It is well known that stock markets tend to be manic-depressive. It oscillates between extreme emotions of euphoria and depression. These extreme emotions catch most investors on the wrong foot. Retail investors, particularly the new ones, buy excessively during the euphoric bull-runs and panic and exit during depressive times. History tells us that this is just the opposite of a sound investment strategy. Take, for instance, the case of an investor who entered the market in December 2007. The economy was firing on all cylinders: GDP growth was above 9 percent and corporate profits were galloping at 25 percent. Macros like fiscal and current account deficits were in a sweet spot and capital inflows were buoyant. Optimism was widespread and exuberance had taken the Sensex above 20000. But this good time was the wrong time to invest aggressively in the market. An investor who invested in December 2007 would have seen the value of his investment crash by more than 50 percent by December 2008.
Now, consider another good example in recent history. By mid 2013 Indian economy was doing terribly. Growth had plummeted to below 5 percent in a quarter. Fiscal deficit, current account deficit and inflation were flashing red. India was among the worst performing ‘fragile five’ economies and the market had crashed. But this bad time was actually a good time to invest in the market. An investor who invested in those bad times would have earned 40 percent returns in the next one year.
The takeaway from this experience is simple: Good times, particularly euphoric times, are not the best times to invest aggressively; and, more importantly, bad and depressive times often turn out to be classic investment opportunities.
History need not repeat exactly in the same manner. Take the present times: there is bad news all around on the economic front. The economy is in a serious slowdown and demand in segments like automobiles has crashed. Tax collections are flashing red and fiscal deficit is rising. Exports are stagnant and the global economy, too, is slowing down. But, it is important to appreciate the fact that this pessimism is not in the price. With Sensex at all time highs, market is fully valued, in fact a bit over-valued when compared to historical valuations. In brief, there is a mismatch between the economy and markets. So, the relevant question is: How should investors respond?
We are presently witnessing a ‘hope rally’ in the market. Corporate tax cuts have turned out to be a game-changer from the market perspective. There are expectations regarding cuts in personal income tax, reforms in taxation relating to capital market, privatization and structural reforms like in land and labour. The government has understood the urgent need for reforms to turn the economy around, and more importantly, this government has the political capital to invest in reforms. This hope is driving the market.
Opportunity for a tactical trade
Long-term investors should continue to remain invested in quality, though highly priced. These consistent compounders will continue to do well in future too. But, it appears that there is opportunity for a tactical trade in the mid-cap space where valuations are attractive. The present polarized valuations – a high premium for quality and discount for mid and small-caps- are likely to witness some shift in the coming months. Investment in mid cap funds like Axis Mid cap, L&T Mid cap and in multi-cap funds like Kotak Standard Multi-cap and ABSL Equity Fund have the potential to fetch good returns in the medium term. So, while remaining invested in quality, though expensive, investors can go for a tactical trade in mid-caps. Of course, patience would be an essential pre-requisite.
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Posted: November 2019